Sale of lessor companies and similar arrangements: anti-avoidance: losses carried forward derived from the expense
Section 386 CTA 2010
Section 386 extends the period over which the benefit of the expense can be utilized in certain circumstances.
It comes into play when:
- the expense produces a loss in the ‘new’ accounting period (period 1) that follows the change of ownership; and
- that loss, or part of it, is not utilized and therefore becomes a loss that is carried forward into the ‘subsequent accounting period (period 2 etc); and
- The new period starts within 5 years of the relevant day and does not start as a result of another qualifying change of ownership.
Where these conditions are met the loss created by the expense (the derived loss) that is carried forward is adjusted in value and treated as an expense of the next accounting period. The loss is therefore available to surrender as group relief.
A Ltd draws up accounts to 31 December. The company is carrying on a business of leasing plant or machinery and there is a qualifying change of ownership on 4 December 2019 when the company is sold to the X Group. The relevant day is 4 December 2019.
As a consequence of the sale A Ltd is required to bring its accounting period to an end on 4 December 2019 and a new accounting period starts on 5 December 2019 (period 1). The company computes an income and corresponding expense amount of £100m. £100m is an expense of period 1 which runs from 5 December to 31 December 2019, a period of less than one month. A Ltd computes its profits for the period ended 31 December 2019 and finds it now has a loss of £98m.
The X Group draws up accounts to 31 December so that the corresponding accounting period for group relief purposes is the period to 31 December 2019. The X group has profits in the period of only £48m. The profits are insufficient to utilize the £98m loss so, but for section 386, the remaining loss (£50m) would be carried forward into period 2 (year ended 31 December 2020) where, but for section 386 its use would be limited to set off against profits of the same trade..
The £50m loss is a loss of the new accounting period - period 1 - and it is not utilized but carried forward into the subsequent accounting period - period 2.
Period 2 starts within 5 years of the relevant day - 4 December 2019 - and A Ltd is therefore able to treat that part of the loss that derives from the expense as an expense of the subsequent accounting period - period 2.
The whole of the loss remaining of £50m is derived from the expense. A Ltd can augment this loss using the formula:
And treat the augmented amount as an expense of period 2.
- DL is the derived loss - £50m;
- D is the number of days in the accounting period in which the loss was made - 27 days; and
- R is the percentage rate applicable to overpaid tax (section 826 ICTA and section 178 FA 1989). Assume that the percentage rate is 3%.
50m x 27 x 3% = 40.5m
Divided by 365 = 111k (approx)
111k is added to the 50m loss.
A Ltd can compute the profits of period 2 with a deduction of £50.111m.
There are rules to ensure that only that part of the carried forward loss that is attributable to the expense is afforded this special treatment. And for this purpose the expense is treated as the final amount to be deducted. This is illustrated in the following examples.
Using the same facts as in example 1, say there is already a loss of £120m in period 1 before the deduction of the expense of £100m. The final loss of period 1 is £220m. £48m is utilized as group relief in period 1 leaving £172m to carry forward into period 2.
Not all of the £172m loss is derived from the expense. The company must compute the loss of period 1 treating the expense as the final amount to be deducted.
As the £172m exceeds the £100m expense amount only £100m is to be taken into account when computing the expense applicable to period 2.
Again, using the same facts as in example 1, say there is a profit of £10m in period 2. The residual loss of £50m carried forward from period 1 would normally reduce these profits to nil with the remaining £40m being carried forward to period 3.
The position before deduction of the sale of lessor company expense in period 1 was a profit of £2m so the loss of £98m derives from the expense. The X group can utilise £48m of this loss in the period to 31 December 2019, leaving £50m to be taken into account when computing the amount to be treated as an expense of period 2. This turns the profit of £10m to a loss of £40.111m which is available to utilise as a loss of that accounting period, and so is available for group relief.
Again using the same facts as in example 1, say there is a profit of £10m in period 2. We know from example 1 that A Ltd can compute the profits of period 2 with a deduction of £50.111m This turns the profit of £10m into a loss of £40.111m which is available to utilise as a loss of that accounting period, and so is available for group relief
Using the same facts as in example 1, say there is a further qualifying change of ownership of A Ltd on 17 March 2020. Period 2 will be terminated on 17 March 2020 and a new accounting period (period 3) will start on 18 March 2010 and run to 31 December 2010. Period 3 is a ‘subsequent accounting period’ that starts within 5 years of the relevant day (5 December 2019) but it starts as a result of a qualifying change of ownership and therefore the special treatment of a loss carried forward into the accounting period cannot apply.